Bulldog v. Massachusetts

April 9, 2012

Add the point of this case to the JOBS Act

There’s one more thing about the JOBS Act that’s worth noting.

While the new statute does remove the ban on general solicitations for hedge funds and other private investment pools sold exclusively to accredited investors, it leaves open for the SEC to determine how much information the funds can convey to would-be investors before qualifying them as accredited.

That’s where Bulldog Investors v. Commonwealth of Massachusetts comes in. In that case-which will soon be either heard by the U.S. Supreme Court or mooted by SEC regulation under the JOBS Act – three of Phil Goldstein’s hedge funds are challenging the right of the State of Massachusetts to require them to register their otherwise exempt securities if the funds promote themselves on websites available to Massachusetts residents (which all websites presumably are). Phil Goldstein is the hedge fund operator who, in 2006, successfully challenged the federal regulation that would have required any hedge fund manager with 15 or more investors in its funds to register with the SEC.In Bulldog, Goldstein argued unsuccessfully in the Massachusetts courts that restricting the right of his funds to be described on a website available to any visitor – including non-accredited investors who cannot purchase them – deprives both the funds and members of the public who have no interest in purchasing fund interests (such as journalists, academics and research analysts) of their First Amendment rights to free commercial speech.

Massachusetts prevailed in its state courts by arguing that its statute (and the federal private offering exemption on which it is modelled) is a legitimate and necessary limitation on the sale of potentially fraudulent securities to unsophisticated investors. The state courts relied on the well-settled principle that commercial speech can be legally regulated to serve a substantial state interest such as promoting the integrity of the capital markets by ensuring a fully informed investing public. Their final opinion was that hedge fund advertising to the general public “would tend to increase the likelihood of sales to ineligible persons who may be persuaded to invest without the full information that registration would provide.”

The issue left open to the SEC by the JOBS Act, and central to the Bulldog case, is whether private placement regulation should attach at the point of sale and not at the earlier point of offer, where both federal and Massachusetts law currently collide with hedge funds’ First Amendment rights to free commercial speech. Massachusetts has so far succeeded in persuading its state courts that its registration regime is designed to avoid even the possibility of consumer deception, and it exempts only “offerings” made exclusively to accredited investors who are deemed to be able to inform themselves of the necessary investment information. Website promotions are deemed to be “offers” under both federal and Massachusetts law.

Constitutional law Professor Laurence Tribe of Harvard will be arguing Bulldog’s case if it goes before the U.S. Supreme Court. His attack on the Massachusetts law concludes that, while it would permit Bulldog’s website to be read by accredited investors, “[i]ronically, the only people to whom Bulldog is not permitted to supply the information are the very people who cannot act on it to buy the securities. . . . Denying information to researchers, journalists, students, and other non-market participants cannot possibly promote the “integrity” of the market.”

We should find out whether Bulldog is mooted by SEC regulation or, if not, pursued by Phil Goldstein, by July of this year when the SEC issues its revised private placement rules under the JOBS Act. Given what we already know about the agency’s concerns in this area, however, the hedge fund industry should probably expect some narrowing of its new advertising safe harbor.